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Play the Dollar Rally with Currency Mutual Funds

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The US dollar very recently has been on a roller-coaster ride, swinging up and down on almost alternate days. However, the general trend this year for the US dollar has been a sharp run toward the north. The sooner-than-expected rate hike fears, juxtaposed with the ECB’s commencement of the stimulus measures helped the dollar spike to a 12-year high against the euro. The US dollar has gained against most key currencies.

Recently, the correlation between the US dollar and equities has been prominent too. A stronger dollar has affected the US benchmarks. However, a stronger dollar and the subsequent loss in equities do not mean that US investors will be on the losing side while their currency garners pace.

A stronger dollar can be profitable too for investors. Domestic companies that are major importers and foreign ADRs that are major exporters to the US, give investors a chance to profit. Of late, the trend of Reverse Yankees has also been gaining strength to play the dollar surge. (Read: Euro Collapse No Longer a Major Concern for US Companies)

What for Mutual Fund Investors?

For mutual fund investors on the other hand, there are a number of currency-focused mutual funds that should help them play the dollar rally. Investors looking to play the dollar movement may bet on currency-focused mutual funds. These mutual funds invest in currencies. They may use money market instruments, derivative instruments and may include forward currency contracts among others. These mutual funds may be tracking the Dollar index, which is measure of the currency against a basket of foreign currencies.

The advantage of these funds is that they track currency fluctuations. Investors in these mutual funds know that their investments are concentrated on currencies. In case of other mutual funds, investors may have to worry about factors like if the fund managers are hedging against foreign currency exposure. A strong dollar may also adversely affect multinationals’ margins and other sector mutual funds may underperform.

Dollar-Euro Parity

There are calls now for a one-to-one exchange rate between currencies, or in simple terms – a dollar-euro parity might be in the cards. The parity existed when the euro was introduced, and it happened again in Nov 2002.

Changing money supplies and the contrasting central bank policies between the two regions have been fueling the chances of the parity. Moreover, there are heightened chances of the US Fed raising interest rates and cutting down the money supply. This will further make dollar-denominated assets more valuable.

Why Dollar May Trend Up

HSBC Holdings raised its euro forecast for 2016 and 2017. HSBC predicts the euro will rise against the dollar to $1.1 by 2016 and to $1.2 by 2017 as they believe the greenback is the second-most overpriced currency in the world.

However, Goldman has forecasted the euro to reach parity with the dollar by September. It is expected to further fall to 80 cents by the end of 2017. Goldman predicts the dollar will show strength as the U.S. economy continues to gradually expand ahead of the inevitable hike in interest rates.
Strategists at BNP Paribus also believe the euro will hit parity with the dollar by the end of 2015. Data from the U.S. Commodity Futures Trading Commission showed bets by hedge fund managers that the dollar will gain against the euro jumped 27% since the beginning of the year and currently remains at a two-year high.

Portfolio managers have also invested in dollar-denominated assets expecting higher returns. Fears of a sooner-than-expected rate hike may have subsided for now, but chances of a stronger dollar still exist as the Fed Chair Janet Yellen did not rule out the possibility of a rate hike in June. Higher rates will spur demand for dollar, as dollar-denominated assets would provide higher returns.

Meanwhile, analysts believe the ECB’s massive asset purchasing program will continue to pull down the euro, eventually boosting the dollar.

Dollar against Key Currencies

The chart shows US dollar’s performance against key currencies:

Performance

Mar'15

3 Months

YTD

1 Yr

US Dollar ($) ⇨ Euro (€)

2.8

11.6

11

26.3

US Dollar ($) ⇨ Japanese Yen (¥)

-0.4

-1.3

-0.6

15.9

US Dollar ($) ⇨ British Pound Sterling (£)

3.8

4.3

4.7

11.9

Funds in Focus

Given the surge in US dollar, it is obvious that currency mutual funds that track the rising dollar will be on the winning side. So, investors believing more upside in the dollar may invest in them. On the contrary, the funds with bearish approach to the dollar have been trending south.

Among the gainers and with favorable Zacks Mutual Fund Rank is ProFunds Rising US Dollar Investor (RDPIX - MF report).

RDPIX seeks daily return that is inverse of the daily performance of the currencies included in the U.S. Dollar Index. The index measures US dollar’s performance against the performance of 6 key currencies. The weightings are - euro 57.6%; Japanese yen 13.6%; British pound 11.9%; Canadian dollar 9.1%; Swedish krona 4.2% and Swiss franc 3.6%. The fund prospectus notes: “Accordingly, as the value of the U.S. Dollar appreciates versus the Benchmark, the performance of the Fund increases”.

Also, ProFunds Rising US Dollar Service (RDPSX - MF report) belonging to the Services class has been profitable. It has returned 6.7% and 17.6% year to date and in the last 1 year, respectively. The fund also carries a Zacks Mutual Fund Rank #2 (Buy).

Meanwhile, funds with their strategies focusing on weakening dollar or the ones that seek return inverse of the U.S. Dollar Index’ performance has been on the losing side this year.

Rydex Weakening Dollar 2x Strategy A (RYWDX - MF report) for example has lost 32.8% over the last one-year period and 14% so far this year. This fund seeks return that is 200% inverse of the U.S. Dollar Index’s performance on a daily basis. The fund involves in short sales of securities included in U.S. Dollar Index. The fund carries a Zacks Mutual Fund Rank #5 (Strong Sell).

Another Zacks Mutual Fund Rank #4 (Sell) fund, Lord Abbett Emerging Markets Currency B (LDMBX - MF report) has lost 8.6% over the last one year. The fund invests majority of its assets in instruments offering exposure to emerging markets currencies and in emerging markets currencies denominated fixed income instruments. Asia, Africa, the Middle East, Latin America, and Europe make up the emerging markets list here.

Both these funds gained 3.8% and 1.5% over the last 1 week as dollar showed some weakness. However, the U.S. dollar’s recent pullback vs. the common currency is just a short-term blip, with the primary strengthening trend still firmly in place. So, holder of the sell-rated funds should consider dropping them from their portfolio, while the top-ranked funds should be a good addition.

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